The Economist: Labor force participation in the spotlight

Typically a rather obscure series of data, the labor force participation rate has recently emerged as a flashpoint. At issue is whether the U.S. jobs situation is actually improving.

On the "yes, it is" side of the argument are a string of monthly job gains and a slight drop in the unemployment rate.

On the "no, it's not" is the fact that the number of Americans not working is on a decidedly upward trend and, according to this line of thought, is a reflection of the large and growing pool of people who have simply given up on finding a job and, thus, no longer show up as unemployed.

So is the recent drop in unemployment good news, or is it just a reflection of how bad things have gotten? In my opinion, the truth is somewhere in between the two.

The related question then closely follows: Why has the labor force participation rate fallen to its lowest level in decades? Let's start with a little background on the key data series.

The government uses two different surveys to determine widely reported employment statistics. The payroll survey, which focuses mostly on companies and government agencies, is used to determine the number of jobs created. It is based on forms submitted to the Labor Department by companies and agencies that also include wages and hours, as well as other data.

The second survey, a household survey based on a information from 60,000 homes, is used to determine the unemployment rate. The respondents are asked if the adults in the household have a job. If they do not, then they are asked if they have actively looked for a job in the past four weeks.

If they are looking, they are counted as unemployed. If they are not looking (for whatever reason), they are counted as "not in the labor force." Thus, there can be only a small increase in jobs, but the unemployment rate can drop, as was the case in April, as well as other strange combinations.

In addition, any of these datasets are also subject to measurement error, as evidenced by the frequent revisions which are required.

The number in the labor force is obviously a key aspect of the calculation, and how it's changing influences the unemployment rate. Starting at the top, you have the total U.S. civilian population age 16 and over, which is not in an institution (including jail as well as nursing homes). That group is then divided into those who are in the labor force and those who are not. The labor force is then divided into those who are employed and those who are unemployed.

Over time, therefore, population growth tends to push the total potential labor force upward, and a certain number of new jobs need to come online just to maintain the status quo. The other dynamic at work is the "labor force participation rate," which has recently received a lot of attention.

The number of people not in the labor force is growing, meaning that the labor force participation rate is falling. In fact, the participation rate has dropped to its lowest level since the 1980s.

The question then becomes: why? Is it because people have given up looking for work and, thus, fallen into that "not in the labor force" category? Without a doubt, there is some of this phenomenon.

The recent recession has left millions of Americans out of work for a very long time; a recent report from the Bureau of Labor Statistics indicates that some 5.1 million Americans, 41.3 percent of the total unemployed, have been jobless for 27 weeks or more. After six months of searching, there would doubtless be a tendency to throw in the towel.

There is also, however, an element of personal choice. Anyone who chooses to leave the workforce would also no longer be counted as a participant. There are countless valid reasons an individual might decide against working.

Stay-at-home moms and dads, persons pursuing other non-commercial interests, those taking early retirement by choice - individuals in transition - all of these may choose to leave the workforce for quality-of-life reasons.

The other major reason to leave the workforce, of course, is retirement. The 2010 Census indicates that the U.S. population 65 and older is now larger in terms of size and percent of the population than ever. In 2010, there were 40.3 million people 65 and older, 13 percent of the population. By comparison, in 1980, there were fewer than 25.6 million persons aged 65 or older, 11.3 percent of the population. As the large group of Baby Boomer age, this pattern will become even more pronounced.

Casting recent trends in unemployment in the most favorable light yields a picture of job gains and falling ranks of people searching for work. On the other hand, a dwindling labor force could produce the same result in the unemployment rate without actually signaling underlying improvement.

In fact, certain pundits would have you think the recent drop in participation is a hugely significant and dire event caused by millions of Americans simply giving up on ever finding work. As I said, at the outset, the truth of the matter lies somewhere in between.

Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.